You`d Better Take Another Look At W-4

March 14, 1988|By Sallie Gaines.

Last year will be remembered as the year of the W-4 snafu, when perfectly intelligent and sensible people couldn`t make head nor tails of the new form used to determine federal income tax withholding. The bad news is, for many people, the saga of the W-4 isn`t over.

Even people who find, after struggling through their 1987 tax return, that the money withheld from paychecks covered their tax liability may want to take another look at that W-4.

``We would encourage people to take a look at their personal withholding because the law has changed again in 1988,`` said Michael McGrail, spokesman for the Internal Revenue Service. ``While it is not specifically required by law, as it was a year ago, it`s probably still a good idea.``

Dennis Marx, tax partner with the Chicago office of the accounting firm Ernst and Whinney, said reviewing withholding and estimated payments should be an automatic part of tax planning for 1988.

The biggest change in 1988 is that the number of tax brackets drops to two, 15 percent and 28 percent, from last year`s five, ranging from 11 percent to 38.5 percent.

That means that withholding appropriate for a 38.5 percent bracket may be too much for a 28 percent bracket, McGrail said. Conversely, withholding what was adequate for an 11 percent tax rate may not be enough when that rate jumps to 15 percent.

The second major change is the decreasing benefit of some deductions. In 1987, for example, taxpayers could deduct 65 percent of their personal interest, such as credit cards or car loans. In 1988, only 40 percent of such interest will be deductible.

People with lots of consumer interest may need to boost withholding, McGrail said.

But people won`t know whether their taxes for 1988 will go up or down unless they work through the numbers now, Marx said.

For the same reasons, people who pay estimated taxes may want to examine whether their quarterly payments are sufficient, Marx said.

Estimated taxes and withholding need to be pretty much on target because the Tax Reform Act of 1986 also toughened rules on how much tax must be prepaid to avoid penalty. In the past, taxpayers were in the clear as long as their withholding or estimated payments equaled 80 percent of the total taxes owed. That`s now 90 percent.

Originally the 90 percent rule was to be effective in 1987, but the new W-4 that all employees were required to fill out last year proved to be lengthy and confusing, so the IRS kept the 80 percent rule for 1987.

As before, taxpayers will be all right if their withholding or estimated payments equal the previous year`s total tax liability, even if it falls short of the current year`s tax bill, McGrail added.

The W-4 should be available from all employers. It also is available from the IRS.

Marx suggested that, after the 1987 tax return is completed, taxpayers try to estimate what the same numbers will be in 1988. That means estimating everything, including salary, deductions, credits, interest and dividends, then figuring the tax using the 1988 rates.

``Unless you sit down and try to do 1988 taxes now, it`s going to be a surprise to you,`` Marx said. ``You`re either short of cash to pay the tax, or you`ve made an interest-free loan to the government.``

Probably the most common mistake people make when estimating their finances is guessing too low on what their income will be.

``Then they spend it and get surprised by the higher tax bill,`` Marx said.